Forget Capping, The EU Should Do Away With Banker Bonuses

While the EU should be applauded for tackling the thorny issue of bank bonuses, my
concern is that the plan to cap payouts at a year's salary will
have perverse consequences. Already base salaries in the banking
sector have been rising sharply as regulators try and choke off
the multimillion-pound annual bonus awards. The EU's plan could
lead to more pressure for a rise in fixed pay.

Banks have increased salaries across Europe by 37% in the past
four years in response to a crackdown on bonuses and pressure
from regulators to claw back some rewards if bets go wrong later
on.

Banks are very good at getting round the letter of the law and
bankers are very competitive. Bank bosses say they are held to
ransom by star traders who threaten to walk off to a rival if
they believe they are not compensated adequately.

However, bank executives should dig their heels in and resist
calls to jack up wages if bonuses are restricted. Few banks are
hiring at the moment since all are facing a squeeze on profits.
Star bankers probably have few options for poaching by rivals and
the threat to leave could be an empty one.

Investment banks generally pay fairly low salaries to keep their
fixed costs down. In a good year, they can pile on the rewards in
the annual bonus round. In a bad year, they can cut back on
bonuses rather than sack a load of trained staff.

That's the theory. What has tended to happen is that bankers
continue to get paid large bonuses even if it has been a
loss-making year for the bank as a whole. Look at RBS: it has
just announced a £5bn loss along with a £287m bonus payout for the
investment bank. Stephen
Hester, the CEO, said bonuses were a lot lower than in
previous years, but most people would question why they are being
paid at all.

How do the vast majority of people who work in the bank branches
and deal directly with the customers feel about this? Starting
salaries for branch staff are around £13,000 and Unite, the union
at Barclays,
recently said that some of the staff were eligible to claim tax
credits to make ends meet. This cannot be good for morale across
the banks when those who are its public face are struggling on
low pay, jobs are being cut but a chosen few investment bankers
are paid millions.

I would suggest scrapping bonuses altogether and introducing a
company-wide profit share. It works for John
Lewis, where every member of staff gets the same percentage
of their salary as a share of profits. Obviously, those on higher
pay get more. But this is a big motivator for those who work
there. It also gets round the reward for apparent failure when
banks pay bonuses without actually making any money. If there's
no profit, there shouldn't be any profit share.

PIRC, the
influential pensions investment adviser, says the EU plan should
be a starting point for a discussion about the effectiveness of
variable pay in general. Some shareholders are beginning to doubt
that it works in the right way and share-based awards and bonuses
have driven pay packages for bankers and top executives to
sky-high levels.

So the EU is right to take on the toxic issue of bank bonuses.
Its plan hopefully will work to reduce payouts. There are also
some new bank bosses in charge such as Sir David
Walker and Antony Jenkins at Barclays who are talking about
reforming pay structures. Maybe they can use this cap to exercise
some restraint over pay.

But shareholders and regulators should watch the banks like hawks
to see they don't just boost salaries to compensate for the loss
of bonus potential. Given the way banks behave, this is what I
fear may happen.